In 1495 or thereabouts, Leonardo da Vinci, the genius’s genius, noted a list of things to do in one of his famous notebooks. His to-do lists, written in mirror writing and interspersed with sketches, are magnificent. “Find a master of hydraulics and get him to tell you how to repair a lock, canal, and mill in the Lombard manner.” “Ask the Florentine merchant Benedetto Portinari by what means they go on ice in Flanders.” And the deceptively brief “Draw Milan.”1
This list included the entry: “Learn multiplication from the root from Maestro Luca.”2 Leonardo was a big fan of Maestro Luca, better known today as Luca Pacioli.3 Pacioli was, appropriately enough, a renaissance man—educated for a life in commerce, he was also a conjuror, a master of chess, a lover of puzzles, a Franciscan friar, and a professor of mathematics. But today Luca Pacioli is celebrated as the most famous accountant who ever lived.
Pacioli is often called the father of double-entry bookkeeping, but he did not invent it. The double-entry system—known in the day as bookkeeping alla veneziana, in the Venetian style—was being used two centuries earlier, at about 1300.4 The Venetians had abandoned as impractical the Roman system of writing numbers and were instead embracing Arabic numerals. They may have also taken the idea of double-entry bookkeeping from the Islamic world, or even from India, where there are tantalizing hints that double-entry bookkeeping techniques date back thousands of years.5 Or it may have been a local Venetian invention, repurposing the new Arabic mathematics for commercial purposes.
The double-entry system records each transaction more than once and employs a system of cross-checks. It’s a sophisticated and complex method. Before this Venetian style caught on, accounts were rather basic. An early medieval merchant was little more than a traveling salesman. He had no need to keep accounts—he could simply check whether his purse was full or empty. A feudal estate needed to keep track of expenses, but the system was rudimentary. Someone would be charged to take care of a particular part of the estate and would give a verbal “account” of how things were going and what expenses had been incurred. This account would be heard by witnesses—the “auditors,” literally “those who hear.” In English the very language of accountancy harks back to a purely oral tradition.6 The Chinese had written accounts, but they focused more on the problem of running a bureaucracy than running a business—in particular, they weren’t up to the problem of dealing with borrowing and lending.7
But as the commercial enterprises of the Italian city-states grew larger, more complex, and more dependent on financial instruments such as loans and currency trades, the need for a more careful reckoning became painfully clear. We have a remarkable record of the business affairs of Francesco di Marco Datini, a merchant from Prato, near Florence. Datini kept accounts for nearly half a century, from 1366 to 1410. They start as little more than a financial diary, but as Datini’s business grows more complex, he needs something more sophisticated.
For example, late in 1394 Datini orders wool from Mallorca, off the coast of Spain. Six months later the sheep are shorn; several months after that, twenty-nine sacks of wool arrive in Pisa, via Barcelona. The wool is coiled into thirty-nine bales. Twenty-one go to a customer in Florence. Eighteen go to Datini’s warehouse—arriving in 1396, more than a year after the initial order. There they are beaten, greased, combed, spun, teaseled, dyed, pressed, and folded by more than a hundred separate subcontractors. The final product—six long cloths—goes back to Mallorca via Venice, but they don’t sell in Mallorca and so are hawked in Valencia and North Africa. The last cloth is sold in 1398, nearly four years after Datini originally ordered the wool.8
No wonder Datini was so anxious and insistent on absolute clarity about inventory, assets, and liabilities. He berated one befuddled associate, “You cannot see a crow in a bowlful of milk!” and declared to another, “You could lose your way from your nose to your mouth!” But Datini himself did not get lost in a tangle of his own financial affairs, because a decade before ordering the wool he began using the state-of-the-art system of bookkeeping alla veneziana.9
So what, a century later, did the much-lauded Luca Pacioli add to the discipline of bookkeeping? Quite simply, in 1494, he wrote the book.10 And what a book it was: Summa de arithmetica, geometria, proportioni et proportionalita was an enormous survey of everything that was known about mathematics—615 large and densely typeset pages. Amid this colossal textbook, Pacioli included twenty-seven pages that are regarded by many as the most influential work in the history of capitalism. It was the first description of double-entry bookkeeping to be set out clearly, in detail, and with plenty of examples.
Amid the geometry and the arithmetic, it’s a practical guide. Pacioli knew that his readers might be doing business from Antwerp to Barcelona, facing different customs and measurements in each city. “If you cannot be a good accountant,” he warns, “you will grope your way forward like a blind man and may meet great losses.”
Pacioli’s book was sped on its way by a new technology: half a century after Gutenberg developed the movable-type printing press, Venice was a center of the printing industry.11 Pacioli enjoyed a long print run of two thousand copies, and his book was widely translated, imitated, and plagiarized across Europe.
Double-entry bookkeeping was slow to catch on, perhaps because it was technically demanding and unnecessary for simple businesses. But after Pacioli it was always regarded as the pinnacle of the art. And as the industrial revolution unfolded, the ideas that Pacioli had set out came to be viewed as an essential part of business life; the system used across the world today is essentially the one that Pacioli described.
But what was that system? In essence, Pacioli’s system has two key elements. First, he describes a method for taking an inventory and then keeping on top of day-to-day transactions using two books—a rough memorandum and a tidier, more organized journal. Second, he uses a third book—the ledger—as the foundation of the system, the double entries themselves. Every transaction was recorded twice in the ledger: if you sell cloth for a ducat, say, you must account for both the cloth and the ducat. The double-entry system helps catch errors, because every entry should be balanced by a counterpart. And this balance, this symmetry, seems almost divine—appealingly enough for a renaissance mathematician.12
It was during the industrial revolution that double-entry bookkeeping became seen not just as an exercise for mathematical perfectionists, but as a tool to guide practical business decisions. One of the first to see this was Josiah Wedgwood, the pottery entrepreneur. At first, Wedgwood, flush with success and fat profit margins, didn’t bother with detailed accounts. But in 1772, Europe faced a severe recession and the demand for Wedgwood’s ornate crockery collapsed. His warehouses began to fill with unsold stock; his workers stood idle. How should he respond?
Faced with this crisis, Wedgwood turned to double-entry bookkeeping to understand which elements of his business were profitable and how to develop them. He realized how much each piece of work was costing him to produce—a deceptively simple-sounding question—and calculated that he would make more money if he actually expanded production, despite the unsold stock. This would reduce the cost of each piece of pottery and allow him to cut prices and win new customers. Other merchants followed Wedgwood’s use of accounts as an aid to decision-making, and the discipline of “management accounting” was born—an ever-growing system of metrics and benchmarks and targets that has led us inexorably to the modern world.13
But in that modern world, accounting does have one more role. It’s not just about making sure that basic obligations are fulfilled, as with a list of credits and debts—nor about a Venetian merchant keeping tabs on his affairs, nor even a pottery magnate trying to get on top of his costs. It’s about ensuring that shareholders in a business receive a fair share of corporate profits—when only the accountants can say what those profits really are.
And here the track record is not encouraging. A string of twenty-first-century scandals—Enron, WorldCom, Parmalat, and of course the financial crisis of 2008—have shown that audited accounts do not completely protect investors. A business may, through fraud or mismanagement, be on the verge of collapse. Yet we cannot guarantee that the accounts will warn us of this.14
Accounting fraud is not a new game. Among the first companies to require major capital investment were the railways: they needed to raise large sums to lay tracks long before they could hope to make a penny in profit. Unfortunately, not everyone got as rich as Cornelius Vanderbilt from these long-range investments. Britain in the 1830s and 1840s experienced “railway mania.” Many speculators plowed their savings into proposed new routes that never delivered the promised financial returns—or in some cases that were never built at all. When the railway company in question could not pay the expected dividends, they kept the bubble inflated by simply faking their accounts. As a physical investment the railways were a triumph, but as a financial punt they were often a disaster. The bubble in railway stocks and bonds had collapsed in ignominy by 1850.15
Perhaps the railway investors should have read up on their Geoffrey Chaucer, writing around the same time as Francesco Datini, the merchant of Prato. In Chaucer’s “Shipman’s Tale,” a rich merchant is too tied up with his accounts to notice that his wife is being wooed by a clergyman. Nor do those accounts rescue him from an audacious con: the clergyman borrows the merchant’s money, gives it to the merchant’s wife—thus buying his way into her bed with her own husband’s cash—and then tells the merchant he’s repaid the debt and to ask his wife where the money is.
Accountancy is a powerful financial technology. It underpins much of the modern financial world: taxation, debt and equity markets, and modern management all rely on it. Yet it does not protect us from outright fraud, and it may well lure us into complacency. As the neglected wife tells her rich husband, his nose buried in his accounts: “The devil take all such reckonings!”16